Washington Municipal Treasurers Association (WMTA) Conference Utility Rate Studies

1. Washington Municipal Treasurers Association (WMTA) Conference Utility Rate Studies Presentation by: Angie Sanchez Virnoche Senior Project Manager – FCS GROUP April 2008 Redmond Town Center, 7525 166th Avenue NE, Suite D-215, Redmond, WA 98052; T: (425) 867-1802 F: (425) 867-1937 www.fcsgroup.com

2. Presentation Outline • Overview • Revenue Requirement • Operation Costs • Capital Costs • Cost of Service • Rate Design • Presentation of Results

3. What is the Purpose of a Rate Study? • To meet the minimum financial requirements and commitments of the utility • To ensure that formal and informal financial policies can be met, such as meeting minimum operating and emergency reserves • To provide long-term stability • To provide a secure funding program for planned capital improvements, upgrades, betterments, and system replacements • To maintain the long-term health and integrity of the utility system

4. Revenue Requirements Connection Charges Cost of Service Public Process Rate Design 1. Revenue Sufficiency 2. Capital Funding Strategy 3. Fairness/Equity 4. Growth Pays for Growth 5. Policy Guidelines 6. Economic Development Incentives 7. Respond to Changing Customer Base 8. Satisfy Debt Requirements What Are You Trying to Accomplish?

5. Revenue Requirements Connection Charges Cost of Service Public Process Rate Design Capital Improvement Program (6-10 years) System Planning Documents Customer Base Growth Forecast Historical Financial Records (1-3 years) Current Year Beginning Fund Balances Current Year Operating Budget Debt Service Schedules Bond/Loan Covenants Fixed Asset Listing Rate and Fee Schedules Detailed Customer Billing Records Water Production/Sewer Treatment Plant Records Special Service Agreements Rate Study Source Documents

6. Overview of Rate Study Process FISCAL POLICIES ECONOMIC ASSUMPTIONS REVENUE REQUIREMENT CAPITAL FUNDING PLAN OPERATING BUDGETS CUSTOMER STATISTICS FUNCTIONAL COST ALLOCATION Solid Waste Water Wastewater Storm COLLECTION DISPOSAL BASE PEAK FLOW STRENGTH QUANTITY QUALITY RECYCLING CUSTOMER CUSTOMER FIRE CUSTOMER CUSTOMER YARD WASTE ALLOCATE COSTS TO CUSTOMER CLASSES DEFINE CUSTOMER CLASSES RATE DESIGN FIXED CHARGES VARIABLE CHARGES

7. Revenue Requirement “Defining Overall Needs”

8. A Successful Rate Study is… A blend of data from ALL departments: finance, engineering, customer service, administration Not simply just a financial exercise!

9. Revenue Requirement Elements • Fiscal Policies • Target reserve levels; debt service coverage, system reinvestment funding • Forecast of Revenue (rate revenue + miscellaneous) • Be careful not to start with beginning balance one time revenue that can mask rate evaluation • Ongoing revenue should support annual needs • Operating & Maintenance Expense • Capital Program & Impacts of Capital Financing Plan • Identify capital needs • Develop funding plan (rates/debt financing/connection charges/reserves) • Revenue Requirement = Fiscal Policies + O&M + Debt Service+ Rate Funded System Reinvestment (capital) Purpose: To determine the amount of annual rate revenue necessary to fund all utility financial obligations.

10. Operating and Capital Costs • Operating Costs • Use historical/budget expenditures • Include known operational changes (staffing, regulatory programs, etc.) • Forecast future costs • Capital Costs • Define capital needs • Identify available resources (grants, developer donations, connection charges, rate funding, reserves, bonds/loans) • Develop funding strategy • Identify annual financial impacts (sensitivity analyses)

11. System Reinvestment Funding • To ensure ongoing system integrity through reinvestment in the system • To charge customers commensurate with the consumption of facility useful lives (rate equity) • To maintain rate stability • System replacement funding benchmarks • Depreciation expense • Depreciation expense net of debt principal • Replacement depreciation • Sinking fund

12. Example Capital Fund Transfer from Rate Revenue

13. Total Rate Revenue Impacts 8.0% Rate Increases with cash (pay as you go) funding only 6.0% Rate Increase w/ Annual Rate Funded Contribution 4.0% Rate Increases w/ Debt 2.0% 0.0% 2007 2014 2021 2028 2035 2042 2050 Impact of Alternative Capital Funding Sources

14. Debt Service Coverage Example

15. Putting It All TogetherRevenue Requirement Forecast

16. Rate Transition Planning

17. Summary of Revenue Requirement • A lot of utilities look at the budget year and stop • Too short a time frame, always playing catch up • Ability to look ahead 3, 5, 10 years allows more thoughtful planning and fewer surprises • Capital funding should be viewed independent from operating activities • Always looking forward, each adjustment makes the projection more certain • When possible, develop a rate transition plan that smoothes rates over the time period being reviewed

18. Common Reserves

19. Cost of Service “Equity Evaluation”

20. Cost of Service Elements • Group customers into classes (single family, multi family, commercial, irrigation, etc.) • Different customer classes place different demands on the system • An equitable distribution of cost shares that considers District specific data: • Measures of usage and demand (level and pattern) • Planning, engineering and design criteria • Facility requirements (fire protection/peaking) • Cost of service analysis determines • total cost by class • unit costs ($/customer, $/usage) The fundamental question: Do cost differences exist to serve the various customer classes of service?

21. Role of Cost of Service • Provides a rational basis for distributing the full costs of utility service to each class of customer • Distributes utility costs amongst customer classes according to the unique demand each class places on the system • An equitable distribution of cost shares that considers utility-specific data • Measures of usage and demand (levels and patterns) • Planning, engineering, and design criteria • Facility requirements (fire protection, peaking, etc.) • End result • Total cost by class • Unit costs ($/customer, $/usage)

22. Analytical Steps of a COSA • Step 1: Functionalize • The preliminary arrangement of costs according to functions performed by the utility. Major functions are defined by system of accounts (e.g. treatment, transmission, distribution, collection, disposal, customer service, administration, etc.). • Step 2: Classify • The process of classifying functionalized costs to cost components (e.g. base use, peak use, flow, customer). • Use of “generally accepted” methodologies • Discussion with staff • Management objectives • Step 3: Allocate • The assignment of classified cost to customer classes of service.

23. Cost Allocation Customer $ 92,403 Fire Protection 51,071 Base Costs 988,325 Extra Capacity 855,989 By Function By Customer Class SF Residential $ 906,211 Low Income 9,067 Commercial 497,000 Multi-Family 532,045 Irrigation 43,465 TOTAL $ 1,987,788 TOTAL $ 1,987,788

24. Cost of Service Summary Equity Evaluation by Class

25. Rate Design “Collecting the Target Revenue”

26. Goals of Rate Design • Collect the target level of revenue • Cost-based (reflect the way cost incurred) • Ability to implement, administer, understand • Policy objectives • Conservation • Risks (revenue stability) • Customer impacts • Social objectives • Affordability • Lifeline rates

27. Example $ Water Single Family $20 /mo. Multi-Family $15 /mo. Commercial $75 /mo. Sewer Single Family $40 /mo. Multi-Family $30 /unit Commercial $40 /mo./ERU Flat Rates • When Used: • No Water Usage Data • Consistent Usage, Demand Patterns • How Applied: • Flat Monthly Charge per Customer or Equivalent Customer • Advantages: • Low Administrative Cost • Stable Revenues • Disadvantages: • Not Proportionate to Demand • No Incentive to Conserve

28. Fixed Charge Plus Volume Rates Example • When Used: • Water Usage (or Sewer Volume) Data Available • Consistent Usage, Demand Patterns • Simplicity/Understandability are Highly Valued • How Applied: • Fixed Charge per Customer or per Equivalent Customer (e.g. Meter Size) • Volume Charge per Unit of Water Consumption [ccf = 100 cubic feet = 748 gallons or 1000 gallons] • Advantages: • Reflects Costs Proportionate to Use • May Adequately Address Efficiency/Conservation Concerns • Disadvantages: • Less Stable Revenues compared to flat rates • Doesn’t Reflect all Cost Distinctions $ Water Fixed Charges $10/mo. Volume Charge $1.00/ccf Sewer Fixed Charges $5/mo. Volume Charge $3.00/ccf

29. Fixed Charge with Allowance Plus Volume Charge Example • When Used: • Water Usage Data Available • Consistent Usage, Demand Patterns • How Applied: • Fixed Charge Includes Volume Allowance • Volume Charge For Usage Over Allowance • Advantages: • Charge Increases for High Usage • Base from Fixed Charge • Disadvantages: • Higher Charges for Low Volume Customers • Reduced Incentive to Conserve $ Water Fixed Charges $15/mo. (includes 5 ccf) Volume Charge $1.00/ccf (for usage over 5 ccf) Sewer Fixed Charges $30/mo. (includes 7 ccf) Volume Charge $5.00/mo. (for usage over 7 ccf)

30. Increasing Block (Tiered) Rates Example • When Used: • Water Usage Data Available • To Reflect Peak Capacity Costs • As Conservation Incentive • How Applied: • Volume Charge Increases as Thresholds are Crossed • Advantages: • Encourages Conservation • Better Relationship to Costs • Disadvantages: • Can be Unfair to Large, Stable Users • Highly Unstable Revenues $ Water Volume Charge 0-10 ccf $1.00 / ccf 11-20 ccf $2.00 / ccf Over 20 ccf $3.00 /ccf Sewer (rarely used) 0-10 ccf $3.00 / ccf 11-20 ccf $6.00 / ccf Over 20 ccf N/A

31. Seasonal Rates Example • When Used: • Water Usage Data Available • To Reflect Peak Capacity Costs • As Conservation Incentive • How Applied: • Volume Charge Varies by Season • May Combine Other Rate Forms • Advantages: • Encourages Conservation • Better Relationship to Costs • Disadvantages: • Can be Unfair to Large, Stable Users • Highly Unstable Revenues $ Water Volume Charge Winter $1.00 / ccf Summer $2.00 / ccf

32. Other Rates • Volume Based Sewer Rates • Rate based on estimated sewage volume • Winter water use used as volume basis • Supports water conservation goals • Outside City Rates - Commonly a rate multiplier ( 1.10 - 1.50) • Premised on “Renter” rather than “Owner” • Higher costs due to location • Benefits of utility government w/o costs • Wholesale Rates • Reflect limited service commitment • Includes a return on utility investment • May include charges for unique services, facilities • Usually lower rates than retail rates • Industrial Rates • Large Customer w/ unique characteristics • Often “tailored” to directly reflect service costs

33. Presentation of Findings

34. Presentation of Findings • Workshop vs. Regular Council Meeting • More interactive/casual • Allows for more detail • Best if first rate study process • Tell the Story - Step by Step • Keep it at a higher level • Avoid too many details • Highlight key areas – cause of increase • Summarize results early on in the presentation • Use Sample Bill Comparisons • Different customer classes at varying usage levels • Identify Policy Decisions Required

35. Public Communications • Tie to Important Public Policy Issues • Environment & Habitat Preservation • Resource Conservation • Responsible Management • Equitable Treatment of Citizens • Safe and Reliable Water • Economic Development Opportunities • Stewardship and Legacy • Link Rates to Key Outcomes • Improved Service • Reliable, Secure Systems • More Stable Rates • Responsible Stewardship • Foster Growth; or Growth pays for Growth

36. What’s Right for You? • What do you wish to accomplish? • What information can you use? • What structures can your system handle? • Will the message be received? • Is it worth it?

37. About the Speaker ANGIE SANCHEZ - SENIOR PROJECT MANAGER B.S., Business Administration, Oregon State University Angie Sanchez is a senior project manager and shareholder for FCS GROUP with over 14 years of experience. Angie has provided financial services for water, sewer, stormwater, solid waste and electric utilities. Her project work includes multi-year financial planning, cost of service studies, rate design restructuring, capital/infrastructure planning, funding alternatives, cost benefit analyses, reserve analysis, and community education and involvement. Angie is often asked to speak at state and national professional conferences and has recently given presentations on topics such as Rates for Small Systems, Utility Rate Strategies and Techniques, Indirect Cost Allocation, and Asset Management Systems. She is a member of the American Water Works Association (Rates and Charges Subcommittee and the Standards Committee); the Washington Finance Officers Association, and the Oregon Municipal Finance Officers Association. Angie can be reached at 425-867-1802 x230 or angies@fcsgroup.com.